Tuesday, July 14, 2009

Alternative payments: Will history repeat itself?

With the phenomenal growth in social networks, online games and virtual worlds, we’re seeing a shift in monetization away from traditional advertising and credit card commerce. Virtual goods and currencies across these platforms, as well as gaming models like free-to-play, are opening a whole new world of things to sell and ways to pay for them. Facebook alone is calculated to have had $500 million of virtual goods and currencies run across its platform as people buy everything from birthday cakes to godfather favor points for their friends and for themselves. In addition to the usual means of paying for these virtual goodies, we’re seeing a host of other methods: Cross-sell exchanges (example: sign up for Netflix, get points/etc.), time barters (example: Fill out a survey), and even new credit sources (example: Charge to your mobile or home phone).

So who are going to become the leading companies providing these new alternative payment methods? Here at Boku, we’re building a new payments service focused on mobile, and we’ve been looking at past winners such as PayPal and BillMeLater to see what key lessons we can learn from their previous success. We talk about these key learnings below and then consider what has changed since then as a guide in predicting the next leading payment platforms.

Key learnings:

Be flexible. When PayPal launched, their original vision was to make money on the float created by allowing people to send money to each other safely over email (technically it started out over PalmPilots, but that’s another story). They shifted to focus on merchants on eBay and other P2P commerce sites and built out the operational capabilities to serve those merchants over time (like its forthcoming Adaptive Payments API, opening up parts of their platform to developers). Some shifts in alternative payments are already happening as lead-generation sites (offers) are starting to add more and more direct payment methods and give them greater web page real estate (pixels).

Ride a wave. PayPal’s was eBay auctions and the need for a trusted intermediary to handle the transfer of funds from buyer to seller. BillMeLater leveraged a mature ecommerce environment and offered a product that reached a segment of customers that either didn’t want to provide financially identifiable info or preferred to buy with credit. (As a disclaimer, BOKU’s CEO, Mark Britto, was an early investor in and board member of BillMeLater). Today virtual goods and currencies have a unique combination of low price-points and near-zero cost-of-goods-sold (COGS), enabling everything from a simple survey to a mobile payment as means to pay.

Reduce friction. Once you have a PayPal account it’s easier to “checkout,” especially on a site you haven’t shopped at before, than entering in your credit card information. BillMeLater was able to tap into a cohort of customers for merchants who still are reluctant to give up financial information over the web. Amazon and other ecommerce sites saw a 5-7 percent lift in customers transacting after adding BillMeLaters payment service. Today, mobile payments are seeing huge revenue growth because they are more convenient than other payment methods online. This is because you either 1) have a phone but not a credit card or bank account (as is the case in emerging countries like India, where only one in three people has a bank account), or 2) it’s just easier to enter your phone number than credit card number, address, zip, CVV number.

Go big. PayPal focused relentlessly on removing barriers to adoption - and they paid high (reportedly between $4-10) acquisition costs for each customer. They invested $100-plus million to grow their market and reaped the rewards of network effect they created. Facebook has the clearest opportunity to be the next network of customers, though others are working on this as well.

Invest in security early. PayPal reportedly had over 50 percent of its original 650 employees working on fraud prevention and customer support. It’s rumored that early fines and fraudulent activity have now brought their CS and fraud team to 2000 or more. Mobile payments, by design, require that you have your phone in order to complete a transaction and since it’s almost always in your possession (or more importantly, you realize as soon as it’s not), have significantly less “stolen identity” fraud than in traditional payment methods such as credit cards. However, all alternative payment methods, including mobile, are going to have to invest in technology and people for fraud prevention as success will bring unwanted attention from the same people that have their sights on PayPal and BillMeLater.

What’s changed?

Focus on merchants before consumers. Open platforms and ease of integration allow merchants (app developers and game publishers) to integrate payments services very easily. A simple iframe with few lines of code are all that are needed. Payments companies don’t have to go straight to consumer. PayPal kick-started their network effect by buying customers, initially for a $10 bonus for each one referred, and they’re now turning more deliberately towards merchants with the Adaptive API. BillMeLater had the benefit of appearing in the checkout flow and either did rev-shares or direct payments to merchants. By existing as an option in the checkout flow, payment companies can skip the higher direct-to-consumer acquisition fees, and focus on those who have intent to purchase instead of hoping to convert registrants to transacting customers.

Payment variety. PayPal does offer the ability to pay with your credit card or bank account, while BillMeLater is essentially a credit application, but what we’re seeing with the alternative payments companies today, especially amongst the “offer” companies, is the aggregation of multiple payment methods. SuperRewards, Gambit, and Offerpal now offer credit cards, mobile phone payments, offers, PayPal, etc. and combinations of the above. The ease of integrating these companies means that the developers can focus on what they do best and still offer all types of payment methods to optimize revenue. But variety is leading to clutter and poor user experience and payment aggregators will focus in the coming quarters on cleaning up the interface to deal with the issues that come about from the paradox of choice.

Ease of integration. When PayPal for checkout arrived it was arguably the easiest of all the payment integration methods (versus PaymentTech, etc.). However, this now seems complex compared to the simple addition of an iframe and a few lines of code to confirm transactions. This ease of integration means that developers are adding, duplicating and swapping payment methods often. Some game developers have four of the top payment aggregators running at once and display them in tabs, for customers to switch between – increasing revenue dramatically. This ease of integration is double-edged. While it has been in our favor recently, we’re aware that this means if we aren’t delivering results, we will be swapped out.

Global faster. Social networks are global. Publishers of apps and games are global. They want domestic and global solutions at the same time. It’s become clear that advertising and credit cards aren’t the only solution to monetizing these services, and in some cases the new payment methods are better able to make money both in North America and Western Europe (the head) as well as emerging markets like Southeast Asia and Latin America (the tail). Boku is live in 50 countries – we take a ‘head and tail’ approach to international reach. An app’s next fan base may just be in Thailand, Malaysia, or Turkey. PayPal got global reach later in their evolution mainly because, at its inception, e-commerce revenue was only coming from 8-10 places.

What’s next?

Based on what we’re hearing from working directly with online games and social applications and in partnering with payments aggregators, it’s clear the industry is shifting from the “revenue at all costs” phase to the “optimization and analytics” phase of monetization. Great apps and gaming companies that are already making $1-30 million are already hiring more web monetization and merchandising experts and user experience, reach and results are being rightfully questioned. Merchants will be looking closely at payments companies and their ability to provide long-term operational value. The rest of 2009 will clearly identify leaders, while others will fail to see 2010. We at Boku are working hard to take these lessons to heart and do our best to become a standard in mobile payments.